The police moved into a subsidiary of recently floated housebuilder Wainhomes yesterday to investigate alleged valuation irregularities, over-invoicing and theft. The company, which responded to the crisis by dismissing its chief executive, also issued a profits warning. Its shares plunged 38 per cent.

The cost of the accounting irregularities, estimated at pounds 2m by the company, will blow a hole in profits which reached pounds 10m in the year to last March but have been under pressure this year as a result of the stagnant housing market.

Gavin Reed, chairman, said the dismissal of Ron Smith was not directly related to the police investigation into Wainhomes Northern but he was unequivocal about the reasons for the chief executive's departure: "In view of the board's loss of confidence in him generally, Mr Smith has been dismissed and will cease to be a director of the company."

Industry sources said they believed two employees at the division had already been sacked and two more suspended. Further dismissals at the highest levels within Wainhomes Northern are expected this week.

Bill Ainscough, founder of what is now the Northern division in 1972 and deputy chairman, will take over as chief executive and will conduct a full review of the company's internal controls.

A senior figure at a rival housebuilder said it was extremely unlikely that the problems at Wainhomes Northern were restricted to that division.

He also pointed to possible conflicts of interest at the company where non-executive directors are among the largest shareholders. Trevor Hemmings, the former chairman, owns 9.3 million shares, 15 per cent of the total, while Mr Ainscough, also a former chairman, owns 14.3 million shares, almost a quarter of the business.

The value of their combined holdings fell by almost pounds 10m yesterday as Wainhomes shares, floated at 170p in March 1994, fell 41p to 68p. At that level, the company is valued at pounds 42.4m.

Mr Smith joined the company in 1989 as chief executive and was paid pounds 192,000 in the 12 months to March 1995. That represented a 35 per cent increase on the pounds 142,000 he earned the previous year. He was on a two- year rolling contract, suggesting he could be in line for a compensation payment of almost pounds 400,000. Negotiations are continuing.

The police investigation is understood to be focusing on the possibility of over-invoicing, whereby staff at the division colluded with outside suppliers or sub-contractors to create false documentation. They are also looking into theft of building materials.

More damaging to the company's reputation in the City, however, is the suggestion by one source that the division's work in progress was deliberately overstated to enhance profits.

It is thought that shared costs, such as roads and sewers, did not appear in the accounts in the early years of a building site's expected life in the hope that rising house prices would hide the impact of higher cost of sales in subsequent years. When house prices stagnated, the discrepancy was discovered.

Analysts yesterday re-drew forecasts for the year to March to show a 40 per cent underlying fall in profits from pounds 10m to pounds 6.1m. After the cost of adjusting Wainhomes Northern's work in progress, profits are expected to emerge at just pounds 4.1m half the level of forecasts before yesterday's news.